How to invest in German development projects
For the last three years, we have been actively looking for projects for investment in Germany, but every year it becomes more and more difficult to find them, because there are fewer of them than the money of those who want to invest in the most reliable European economy. In such a situation, local developers can afford to choose with whom and under what conditions to work.
German developers were in the right place at the right time: today’s German market is filled with money, and apartments in the primary market are finding buyers before construction is completed. This is due to the low cost of borrowed capital: interest on deposits remains negative, the average mortgage rate, according to the data of the German Federal Bank, dropped from 4.42% in 2009 to 1.65% in 2018, and banks willingly finance construction and purchase real estate.
The German market is full of liquidity, but in the future of 2-3 years, the situation may change. The European Central Bank on June 14, 2018 announced the end of the quantitative easing program, the essence of which was the purchase of various assets to inject money into European economies. The result of this policy were low mortgage rates. Now, market players expect the loan capital to rise in price.
Where to invest?
As the market prepares for growth in rates and a reduction in liquidity, we recommend investing in projects with low risks, in locations with a positive demographic situation, a strong economy and a high level of purchasing power.
In general, the G7 includes such locations in Germany: Berlin, Hamburg, Düsseldorf, Cologne, Munich, Frankfurt and Stuttgart. However, the markets of these cities are overheated, and it is difficult to find areas there at an adequate price. For example, in Munich, according to the company LBS, land for construction is sold at prices ranging from 1,300 to 2,400 euros / m². For comparison: in other cities of Bavaria plots cost from 390 to 1 300 euro / m².
It is more profitable to invest in development in the suburbs of large cities. For example, the outskirts of Berlin, Hamburg and Stuttgart are developing rapidly due to the fact that young families are increasingly moving from cities where housing prices have become too high. Also suitable B-locations with a population of 60 thousand people. For example, in Bavaria this is Augsburg, Ingolstadt, Regensburg and Fürth.
Localities in the eastern part of Germany should be chosen carefully, as the economy is weaker there, the potential for price increases is smaller, and the demand for housing is not as great as in the western lands.
Terms of project financing
For the construction of buildings in Germany requires an average of from 1 million to 15 million euros. Construction takes 1.5 – 3 years. Developers rarely invest their own money in a project and receive capital from two sources – from banks (65–80% of capital) and from investors (20–35%).
With today’s market conditions, investors should be cautious about projects with a large share of bank financing. In this case, you can get a high yield, but the sensitivity to price correction will be high, and the negative dynamics of the market can lead to loss of capital. The optimal ratio of borrowed and equity capital is 65/35%.
There are projects that are created under one person. It loss of capitalinvestors invest in club deals. In the latter case, the minimum contribution is usually 100 thousand euros.
Investors provide capital in different ways: they either invest in the form of a loan (mezzanine loan) at 5–10% per annum, or become shareholders, receiving 10–15% per year. Profitability depends on the project location, developer experience, type of real estate and the amount of invested capital. Of course, the paradigm works as always: the lower the risk, the lower the profitability, and vice versa.
A “sleeping” investor in a quality project and in a good location can expect a profit of 8–12% per annum after deducting all expenses and project taxes (but before paying personal income tax).
Why mezzanine loans?
The loan differs from equity participation in the line of creditors. In the event of a negative development of events, the one who provided debt capital is more protected than a shareholder. The latter has the right to super-profit, but, on the other hand, will be the first to lose money if the economy deteriorates.
Many experts say that in the near future there is a risk of stagnation or price correction, since the 10-year cycle is at its peak. Therefore, in my opinion, in today’s conjuncture, participation in a development project through a mezzanine loan may be less risky and more justified. With this option, the investor should count on 7–8% of net profit per year less expenses and taxes. In this case, the risks will be low. For example, in order for an investor to lose money, the German market must collapse in price by 20–25% – I think that such a scenario is unlikely.